My father decided to retire two years ago. He recently invited me to attend an annual investment review with his financial adviser, with the goal of including me in his estate-planning activities.
After some pleasantries, the financial adviser talked about the market in general and then reviewed the performance of my father’s portfolio over the previous year. Like most investors, he did quite well. The only issue that caught my eye was that all his gains were from the equity side of his portfolio vs. the fixed income side, which was down due to the recent rise in rates.
The financial adviser then asked my father a set of questions all advisers ask their clients each year to find out if there had been any new developments in his life that would influence the investment plan they had built together. When most of the answers were ‘no’, he said: ‘Great, so we stay the course and continue the investment plan.’
Not all financial advisers are created equal. Although many do, this particular adviser never talked about how my father’s investment strategy might be affected by what was going on in the market, or where we were in the market cycle.
The graph above shows a typical market cycle. These cycles, and the periods of bull or bear markets within them, can vary in intensity. But over time, most markets generally trend higher. Advisers love to illustrate this point by showing the ‘Had you invested $1 in 1928’ chart, which underscores both the market’s long-term uptrend and the power of compounding. Unfortunately, few clients can stay invested for 85 years. The realities of retirement and the need to drawdown on portfolios for income are serious investor concerns.
How can the market cycle affect an individual’s retirement?
It’s clear we are not at the bottom of the market or even in a bear market. Therefore, are we in a sustained bull market or are we somewhere near the top? The current bull market has lasted for more than four years. Given that bull markets don’t last forever, how might a bear market affect clients in retirement?
The graph below shows an international balanced portfolio with 50% in equity and a 5% annual withdrawal starting in January 2005. Fast forward to December 2012 and the client looks fine. But if you look closely, this balanced portfolio would have been down more than 20% from its initial investment in 2009. Had the client been more heavily invested in equities, the loss would have been even greater.
How would advisers and clients react when a retirement portfolio, which is potentially meant to last 30+ years, is down over 20% in just the first three years? Given that investment portfolios can be a client’s main source of income, many advisers would have probably repositioned the portfolio and increased bonds, thereby missing out on the market rebound. Remember, the above portfolio and drawdown begins 2,5 years before the financial crisis. What if the client retired in mid-2007?
It’s easy to say with hindsight that a client would have stayed the course and not adjusted his portfolio weighting to account for the loss. But when markets are down and fear runs high, that’s when the worst financial decisions are often made.
Clients are in an even more difficult position today, given that rates are still historically very low. Not only are fixed-income returns extremely low, recent history tells us that as rates rise, fixed-income portfolios lose value. Therefore the long-term growth of portfolios is not coming from fixed income, but rather from equity and other asset classes. My father’s portfolio was a perfect example.
Is there an alternative?
The graph below takes the same portfolio discussed earlier and replaces the same equity exposure with equivalent P2strategies funds. The P2strategies international balanced portfolio never goes below 95% of the original investment. P2strategies smooths the investment experience and gives the client the confidence to stay invested over the long term.
Retirement and the drawdown phase of a client’s life can be strongly affected by what the market does in the first few years of retirement. It can often mean the difference between having your portfolio last for the rest of your life, or deplete far too soon.
I would encourage all investors – like my father – to enlist the help and advice of a qualified financial intermediary. Planning needs and decision-making can be complex at the best of times but become even more so as one approaches retirement.